The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Saturday, June 22, 2013

Liam Halligan: true bank reform stymied by lack of political will

In his Telegraph column, Liam Halligan identifies why six years into a financial crisis that rivals the Great Depression there has not been true bank reform anywhere globally: lack of political will.

Why has there been no political will to reform the banks?

Because as one US senator put it: the banks own the place.

Writing about the Parliament's Commission on Banking Standards' report, Mr. Halligan notes that the report contributes valuably in describing just how bad bank behavior was leading up to and since the beginning of the financial crisis.

However, he notes that the report pulls its punches when it comes to making recommendations that would bring about true reform of the banks.

When it comes to mounting a genuine domestic recovery, nothing is more important than “fixing” our banks. When it comes to preparing the UK for the next “systemic moment” on global markets – for there will be one, of that we can be sure – then, once again, our banks are centre-stage.

Yet having been through all 571 pages, I’ve sadly concluded this report will change very little.

That’s because it fails to promote the one reform, above all others, that really must happen if we’re to defuse the “too big to fail” time bomb and prevent the UK’s banking sector, once again, from doing serious damage to its host economy.

Regular readers know that the one reform is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This was the standard for bank disclosure in the 1930s and is entirely consistent with the global securities laws that were passed to ensure that market participants had access to all the useful, relevant information in an appropriate, timely manner so they could independently assess this information and make a fully informed decision.

A major strength of this report is its account of the extent to which existing bank practices work against consumers. Going through it makes the reader angry and, when it comes to the descriptions, the commission has pulled no punches.

“Given the misalignment of incentives in banking, it should be no surprise that deep lapses in standards have been commonplace,” the report booms. While that’s obvious, for a high-powered Parliamentary body to say so still represents progress.

What allowed these deep lapses in standards to take place was opacity. Opacity hid bad behavior by the bankers that was similar, if not identical to, what bankers did in the run-up to the Great Depression.

Everyone knows that sunlight is the best disinfectant and only ultra transparency shines enough sunlight in to disinfect the banking system.

Many of the commission’s 80 recommendations make sense. A new “Senior Persons Regime” could make it harder for boss-class bankers to avoid punishment by claiming responsibilities were delegated and bad decisions collectively taken. Requiring senior managers to sign up to a code of conduct may also help focus minds....

In a display of how far we are from true reform of the banks, all 80 of the commission's recommendations substitute complex regulations and regulatory oversight for transparency and market discipline.

What’s needed is political will – and for the regulators to be sure the political classes will back them if they turn the screw on high-finance white-collar crime.

Such will has been thin on the ground.

A Parliamentary commission’s proposal for a new offence, even if eventually enshrined in law (a big if), will do nothing to change that....

Please re-read the highlight text as Mr. Halligan has nicely summarized the conclusion of the Nyberg Report on the Irish Financial Crisis. Regulators, who are political appointees, will not enforce bank regulations unless they are supported by the politicians. Unfortunately, the politicians have chosen to support the bankers rather than citizens who vote and pay taxes.

So, while the commission’s report is a descriptive tour de force, and is good in parts in policy terms, I don’t believe it will live up to its title and succeed in “Changing Banking For Good”.

The only thing that would change banking for good is requiring banks to provide ultra transparency.

A bank that is unwilling to provide ultra transparency is a bank that is saying it has something to hide. If a bank has something to hide, it should not be eligible for deposit insurance. Without deposit insurance, if the bank fails, there is no need for the taxpayers to bail it out.

I don’t necessarily blame its members for that. They’re working in shark-infested political waters, after all. And radical reforms, while relatively easy for a newspaper columnist to advocate, can unsettle financial markets if proposed by a weighty Parliamentary commission....

Actually, advocating for transparency settles the financial markets. Transparency is the foundation of market confidence.

It is not as if market participants don't know that the banks are hiding losses on and off their balance sheets. What market participants don't know is if their estimate of these hidden losses is higher, lower or approximately the same as the true level of these hidden losses.

The result of call for and adopting transparency is to provide market participants with the data they need to determine if their estimates of the losses was accurate.

In his final speech as Bank of England Governor last week, Sir Mervyn King said “it is vital, as memories of the 2008 crisis fade, that the audacity of pessimism is not lost”.

That’s entirely correct.

So I don’t apologise for being downbeat about our economic prospects as long as our banking sector remains moribund and fundamentally unreformed.

And I don’t apologise for refusing to pretend that this Parliamentary commission’s proposals amount, as has been billed, to a “radical overhaul” of our banking sector – when that is so clearly far from the truth.

Only requiring the banks to provide ultra transparency will truly reform the banks. This would be a radical change.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.